[May 10, 2013] PRIMUS TELECOMMUNICATIONS GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations together with the information in our unaudited condensed consolidated financial statements and the notes thereto included herein, as well as our audited consolidated financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2012. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2012 as well as the section below entitled "-Special Note Regarding Forward-Looking Statements" for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Unless the context otherwise requires, in this Quarterly Report on Form 10-Q, "PTGi" means Primus Telecommunications Group, Incorporated and the "Company," "we" and "our" mean PTGi together with its subsidiaries. Introduction and Overview of Operations We are an integrated facilities-based communications services provider offering a portfolio of international and domestic voice, wireless, Internet, Voice over Internet Protocol ("VoIP"), data, colocation and data center services to customers located primarily in Canada and the United States. Our primary market is Canada, where we have deployed significant network infrastructure. We classify our services into three categories: Growth Services, Traditional Services and International Carrier Services ("ICS"). As of March 31, 2013, we provided these services from our three business units: North America Telecom, BLACKIRON Data and ICS. As of March 31, 2013, our two primary reportable operational segments were North America Telecom and BLACKIRON Data. Our focus has been on expanding our Growth Services in our North America Telecom and BLACKIRON Data business units. Within the North America Telecom unit, Growth Services include our broadband, VoIP and on-net Ethernet services. Our BLACKIRON Data unit contained the pure data center operations in Canada and operated as BLACKIRON Data ULC ("BLACKIRON"), a wholly owned subsidiary of Primus Telecommunications Canada Inc., a Canadian corporation and wholly owned subsidiary of PTGi ("PTCI"). Through our BLACKIRON Data unit, we focused on expansion of our collocation facilities, cloud computing and managed services. Both units fulfilled the demand for high quality, competitively priced communications and data center services. This demand has been driven, in part, by the explosion of data being generated on a daily basis, the globalization of the world's economies, the global trend toward telecommunications deregulation and the migration of communications traffic to the Internet. We manage our Traditional Services, which include our domestic and international long-distance voice, local landline, wireless, prepaid cards, and dial-up Internet services, for cash flow generation that we reinvest to develop and market our Growth Services, particularly in our primary market of Canada. We also provide our ICS voice termination services to other telecommunications carriers and resellers requiring IP or time-division multiplexing access. As discussed below under "-Recent Developments-Divestiture of BLACKIRON," on April 17, 2013, we consummated the divestiture of BLACKIRON. As a result, we will no longer operate a BLACKIRON Data business unit subsequent to such date. In addition, as discussed below under "-Recent Developments-Continued Pursuit of Divestiture of ICS Business Unit," the Company is currently pursuing a sale or other disposition or disposal of its ICS business unit, which no longer is a separate reportable business segment and has been classified as a discontinued operation as a result of being held for sale. 38 -------------------------------------------------------------------------------- Generally, we price our services competitively with the major carriers and service providers operating in our principal service regions. We seek to generate net revenue through sales and marketing efforts focused on customers with significant communications needs, including small and medium enterprises ("SMEs"), multinational corporations, residential customers, and other telecommunications carriers and resellers. Industry trends have shown that the overall market for domestic and international long-distance voice, prepaid cards and dial-up Internet services has declined in favor of Internet-based, wireless and broadband communications. Our challenge concerning net revenue in recent years has been to overcome declines in long-distance voice minutes of use per customer as more customers are using wireless devices and the Internet as alternatives to the use of wireline phones. Also, product substitution (e.g., wireless/Internet for fixed line voice) has resulted in revenue declines in our long-distance voice services. Additionally, we believe that because deregulatory influences have begun to affect telecommunications markets outside the United States, the deregulatory trend is resulting in greater competition from the existing wireline and wireless competitors and from more recent entrants, such as cable companies and VoIP companies, which could continue to affect adversely our net revenue per minute, as well as minutes of use. More recently, adverse global economic conditions have resulted in a contraction of spending by business and residential customers generally which, we believe, has had an adverse effect on our net revenues. In order to manage our network transmission costs, we pursue a flexible approach with respect to the management of our network capacity. In most instances, we (1) optimize the cost of traffic by using the least expensive cost routing, (2) negotiate lower variable usage-based costs with domestic and foreign service providers, (3) negotiate additional and lower cost foreign carrier agreements with the foreign incumbent carriers and others, and (4) continue to expand or reduce the capacity of our network when traffic volumes justify such actions. Our overall margin may fluctuate based on the relative volumes of international versus domestic long-distance services; prepaid services versus traditional post-paid voice services; Internet, VoIP and data services versus fixed line voice services; the amount of services that are resold; and the proportion of traffic carried on our network versus resale of other carriers' services. Our margin is also affected by customer transfer and migration fees. We generally pay a charge to install and transfer a new customer onto our network and to migrate broadband and local customers. However, installing and migrating customers to our network infrastructure enables us to increase our margin on such services as compared to resale of services using other carriers' networks. Selling, general and administrative expenses are comprised primarily of salaries and benefits, commissions, occupancy costs, sales and marketing expenses, advertising, professional fees, and other administrative costs. All selling, general and administrative expenses are expensed when incurred. Emphasis on cost containment and the shift of expenditures from non-revenue producing expenses to sales and marketing expenses has been heightened since growth in net revenue has been under pressure. Recent Developments Divestiture of BLACKIRON On April 17, 2013, PTGi and PTCI entered into an equity purchase agreement (the "BLACKIRON Purchase Agreement"), with Rogers Communications Inc., a Canadian telecommunications company listed on the Toronto Stock Exchange, and Rogers Data Services Inc., a wholly owned subsidiary of Rogers Communications Inc. ("Rogers"), to sell to Rogers all of the outstanding equity of BLACKIRON, which operated our BLACKIRON Data business unit, for approximately CAD$200 million (the "BLACKIRON Transaction"). The purchase price is subject to potential downward or upward post-closing adjustments based on net working capital and cash at closing. In addition, CAD$20 million of the purchase price was placed in escrow to be released 15 months after the closing date, subject to any deductions required to satisfy indemnification obligations of PTGi and PTCI under the BLACKIRON Purchase Agreement. The BLACKIRON Purchase Agreement also contains customary indemnification obligations, representations, warranties and covenants for a transaction of this nature. In 39 -------------------------------------------------------------------------------- addition, subject to certain exceptions, PTGi and its subsidiaries also agreed for a period of two years from the closing date to certain restrictions on competing with BLACKIRON as provided in the BLACKIRON Purchase Agreement. The BLACKIRON Transaction signed and closed on April 17, 2013. The BLACKIRON Transaction was approved by the Board of Directors of PTGi as well as the special committee of the Board of Directors of PTGi (the "Special Committee"), which was originally formed in September 2011 in connection with our strategic review of possible transactions to maximize shareholder value. Pending Divestiture of North America Telecom On May 10, 2013, PTGi announced that PTGi and each of PTHI, Primus Telecommunications International, Inc. ("PTII") and Lingo Holdings, Inc. ("Lingo Holdings", and together with PTHI and PTII, the "Sellers"), direct or indirect wholly owned subsidiaries of PTGi, entered into an equity purchase agreement dated as of May 10, 2013 (the "North America Telecom Purchase Agreement") with PTUS, Inc. ("US Acquireco") and PTCAN, Inc. ("CAN Acquireco" and together with US Acquireco, the "Purchasers"), affiliates of York Capital Management, an investment firm, to sell to the Purchasers all of the outstanding equity of each of Primus Telecommunications, Inc. ("PTI"), Lingo, Inc. ("Lingo"), iPrimus, USA, Inc. ("iPrimus"), 3620212 Canada Inc. ("Primus Canada"), Primus Telecommunications Canada Inc. ("PTCI"), Telesonic Communications Inc. ("Telesonic"), and Globility Communications Corporation ("Globility", and together with PTI, Lingo, iPrimus, Primus Canada, PTCI and Telesonic, the "Companies"), indirect or direct wholly owned subsidiaries of PTGi, for approximately $129 million (the "North America Telecom Transaction"). The purchase price is subject to potential downward or upward post-closing adjustments based on net working capital and cash at closing. The North America Telecom Purchase Agreement contains customary indemnification obligations, representations, warranties and covenants for a transaction of this nature. Certain indemnification obligations are subject to a cap of approximately $12.9 million. In addition, the North America Telecom Purchase Agreement provides that the Sellers must, for 14 months after the closing of the North America Telecom Transaction, maintain a minimum balance of cash and cash equivalents necessary to satisfy PTGi's indemnification obligations under the North America Telecom Purchase Agreement. Pursuant to the terms of the North America Telecom Purchase Agreement, $6.45 million of the purchase price will be placed in escrow to be released 14 months after the closing date, subject to any deductions required to satisfy indemnification obligations of PTGi under the North America Telecom Purchase Agreement. In addition, $4 million of the purchase price will be placed in escrow to cover any payments required in connection with the post-closing working capital and cash adjustments, which escrow amount will be released when such adjustments are conclusively agreed upon. Furthermore, $4.8 million of the purchase price will be placed in escrow to cover certain tax liabilities, which escrow amount will be released after a positive ruling with respect to the underlying matter is received or 30 days after expiration of the applicable statute of limitations relating to the underlying matter. The North America Telecom Purchase Agreement also contains certain termination rights for PTGi, the Sellers and the Purchasers, including the right of PTGi and the Sellers, in certain circumstances, to terminate the North America Telecom Purchase Agreement and accept a superior proposal. If the North America Telecom Purchase Agreement is terminated, in certain circumstances, the Sellers would be required to pay to the Purchasers reasonable costs and expenses incurred by the Purchasers of up to 1% of the purchase price or a termination fee equal to $3.87 million. In certain circumstances in which the North America Telecom Purchase Agreement is terminated or the Purchasers breach the North America Telecom Purchase Agreement, Purchasers would be required to pay to PTGi a reverse termination fee equal to $25 million as liquidated damages. The Companies conduct PTGi's North America retail telecommunications operations in the United States and Canada. The transactions contemplated by the North America Telecom Purchase Agreement were approved by the Board of Directors of PTGi as well as the special committee of the Board of Directors of PTGi. The North America 40 -------------------------------------------------------------------------------- Telecom Transaction will require PTGi stockholder approval and regulatory approvals, and is subject to customary closing conditions. The North America Telecom Transaction is currently expected to close by the third quarter of the year ending December 31, 2013, with the exception of the sale of PTI. Subject to regulatory approvals, the sale of PTI is expected to close subsequent to the third quarter of the year ending December 31, 2013. Approximately $126 million, subject to any adjustments pursuant to the North America Telecom Purchase Agreement, is required to be paid on the initial closing, with the remainder to be paid upon closing of the sale of PTI. Continued Pursuit of Divestiture of ICS Business Unit On June 28, 2012, PTGi's Board of Directors committed to dispose of the Company's ICS business unit. As a result of holding the ICS business unit out for sale, such business unit has been classified as a discontinued operation. The Company continues to actively solicit a sale or other disposition of its ICS business unit. See Note 11-"Discontinued Operations" to the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. In addition to the possible sale or other disposition or disposal of ICS, the Special Committee continues to explore and evaluate other strategic alternatives to enhance shareholder value, which may include (but may not be limited to) a sale, merger or other business combination, a recapitalization, a joint venture arrangement, the sale or spinoff of our assets or one or more of our business units, or the continued execution of our business plans. There is no set timetable for completion of the evaluation process, and we do not intend to provide updates or make any comments regarding the evaluation of strategic alternatives, unless our Board of Directors has approved a specific transaction or otherwise deems disclosure appropriate. Foreign Currency Foreign currency can have a major impact on our financial results. During the three months ended March 31, 2013, approximately 87% of our net revenue was derived from sales and operations outside the U.S. The reporting currency for our condensed consolidated financial statements is the United States dollar (the "USD"). The local currency of each country is the functional currency for each of our respective entities operating in that country. In the future, we expect to continue to derive the majority of our net revenue and incur a significant portion of our operating costs from outside the U.S., and therefore changes in exchange rates have had and may continue to have a significant, and potentially adverse, effect on our results of operations. Our risk of loss regarding foreign currency exchange rate risk is caused primarily by fluctuations in the following exchange rates: USD/Canadian dollar ("CAD") and USD/British pound sterling ("GBP"). Due to the large percentage of our revenue derived outside of the U.S., changes in the USD relative to one or more of the foregoing currencies could have an adverse impact on our future results of operations. In addition, prior to the sale of the Company's Australia operations during the quarterly period ended June 30, 2012, we also experienced risk of loss regarding foreign currency exchange rates due to fluctuations in the USD/Australian dollar ("AUD") exchange rate. We have agreements with certain subsidiaries for repayment of a portion of the investments and advances made to these subsidiaries. As we anticipate repayment in the foreseeable future, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the condensed consolidated statements of operations. The exposure of our income from operations to fluctuations in foreign currency exchange rates is reduced in part because a majority of the costs that we incur in connection with our foreign operations are also denominated in local currencies. We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows of our international subsidiaries and may distort comparisons from year to year. By way of example, when the USD strengthens compared to the CAD, there could be a negative or positive effect on the reported results for our Canadian operating segment, depending upon whether the business in our Canadian operating segment is operating profitably or at a loss. It takes more 41 -------------------------------------------------------------------------------- profits in CAD to generate the same amount of profits in USD and a greater loss in CAD to generate the same amount of loss in USD. The opposite is also true. For instance, when the USD weakens against the CAD, there is a positive effect on reported profits and a negative effect on the reported losses for our Canadian operating segment. In the three months ended March 31, 2013, as compared to the three months ended March 31, 2012, the USD was weaker on average as compared to the CAD and GBP. The following tables demonstrate the impact of currency fluctuations on our net revenue for the three months ended March 31, 2013 and 2012: Net Revenue by Location, including Discontinued Operations-in USD (in thousands) For the Three Months Ended March 31, 2013 2012 Variance $ Variance % Canada $ 53,069 $ 57,906 $ (4,837 ) -8.4 % Australia (1) - 70,129 (70,129 ) -100.0 % United Kingdom (1) 35,161 63,339 (28,178 ) -44.5 % Net Revenue by Location, including Discontinued Operations-in Local Currencies (in thousands) For the Three Months Ended March 31, 2013 2012 Variance $ Variance % Canada (in CAD) $ 53,478 $ 58,010 $ (4,532 ) -7.8 % Australia (1) (in AUD) - 66,453 (66,453 ) -100.0 % United Kingdom (1) (in GBP) 22,612 40,389 (17,777 ) -44.0 % (1) Table includes revenues from discontinued operations which are subject to currency risk. Critical Accounting Policies See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies" in our Annual Report on Form 10-K for the year ended December 31, 2012 for a detailed discussion of our critical accounting policies. These policies include revenue recognition, determining our allowance for doubtful accounts receivable, accounting for cost of revenue, valuation of long-lived assets, goodwill and other intangible assets, and accounting for income taxes. No significant changes in our critical accounting policies have occurred since December 31, 2012. Financial Presentation Background In the following presentations and narratives within this Management's Discussion and Analysis of Financial Condition and Results of Operations, we compare, pursuant to accounting principles generally accepted in the United States of America ("U.S. GAAP") and Securities and Exchange Commission ("SEC") disclosure rules, the Company's results of operations for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. We also present detailed changes in results, excluding currency impacts, since a large portion of our revenues is derived outside of the U.S., and currency changes can influence or mask underlying changes in foreign operating unit performance. For purposes of calculating constant currency rates between periods in connection with presentations that describe changes in values "excluding currency effects" herein, we have taken results from foreign operations for a given year (that were computed in accordance with U.S. GAAP using local currency) and converted such amounts utilizing the same USD to applicable local currency exchange rates that were used for purposes of calculating corresponding preceding period US GAAP presentations. We believe that the comparison of the combined financial results provides management and investors with a meaningful analysis 42 -------------------------------------------------------------------------------- of our performance and trends for comparative purposes. In addition, it should be noted that the application of fresh-start accounting will have a significant non-cash impact on our future results of operations, but will have no impact on the underlying cash flows of the Company. Discontinued Operations 2012 Developments-During the second quarter of 2012, the Company sold its Australian segment. Additionally, the Board of Directors of PTGi committed to dispose of the Company's ICS business unit and as a result classified ICS as a discontinued operation. The Company continues to actively solicit a sale or other disposition of its ICS business unit. As a result of these events, the Company's condensed consolidated financial statements for all periods presented reflect the Australian and ICS business units as discontinued operations for the three months ended March 31, 2013 and 2012. Accordingly, revenue, costs and expenses of the discontinued operations have been excluded from the respective captions in the condensed consolidated statements of operations. The net operating results of the discontinued operations have been reported, net of applicable income taxes as income or loss (where applicable) from discontinued operations. Additionally, the assets and liabilities of ICS have been classified as held for sale assets and liabilities and removed from the specific line items on the condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012. Summarized operating results of the discontinued operations are as follows (in thousands): Three Months Ended Three Months Ended March 31, 2013 March 31, 2012 Net revenue $ 58,789 $ 166,690 Operating expenses 59,902 163,586 Income (loss) from operations (1,113 ) 3,104 Interest expense - (248 ) Interest income and other income (expense) (55 ) 154 Foreign currency transaction gain (loss) (115 ) 2,799 Income (loss) before income tax (1,283 ) 5,809 Income tax (expense) benefit - (1,197 ) Income (loss) from discontinued operations $ (1,283 ) $ 4,612 Results of Operations Results of operations for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 Net revenue: Net revenue, exclusive of the currency effect, decreased $6.8 million, or 10.0%, to $61.2 million for the three months ended March 31, 2013 from $68.0 million for the three months ended March 31, 2012. Inclusive of the currency effect which accounted for a decrease of $0.3 million, net revenue decreased $7.1 million to $60.9 million for the three months ended March 31, 2013 from $68.0 million for the three months ended March 31, 2012. 43 -------------------------------------------------------------------------------- Inclusive of Exclusive of Currency Effect Currency Effect Quarter Ended Quarter-over-Quarter Quarter Ended March 31, 2013 March 31, 2012 March 31, 2013 Net % of Net % of Currency Net % of (in thousands) Revenue Total Revenue Total Variance Variance % Effect Revenue Total BLACKIRON Data $ 9,689 15.8 % $ 8,197 12.1 % $ 1,492 18.2 % $ (56 ) $ 9,633 15.8 % North America Telecom 51,506 84.2 % 59,805 87.9 % (8,299 ) -13.9 % (256 ) 51,250 84.2 % Total Net Revenue $ 61,195 100.0 % $ 68,002 100.0 % $ (6,807 ) -10.0 % $ (312 ) $ 60,883 100.0 % BLACKIRON Data: BLACKIRON Data net revenue, exclusive of the currency effect, increased $1.5 million, or 18.2%, to $9.7 million for the three months ended March 31, 2013 from $8.2 million for the three months ended March 31, 2012. The net revenue increase is primarily due to continued growth in colocation, network connectivity and managed/cloud services. Inclusive of the currency effect which accounted for a $0.1 million decrease, net revenue increased $1.4 million to $9.6 million for the three months ended March 31, 2013 from $8.2 million for the three months ended March 31, 2012. North America Telecom: North America Telecom net revenue, exclusive of the currency effect, decreased $8.3 million, or 13.9%, to $51.5 million for the three months ended March 31, 2013 from $59.8 million for the three months ended March 31, 2012. The net revenue decrease is primarily attributable to a decrease of $3.6 million in retail voice services, a decrease of $1.6 million in local services, a decrease of $1.4 million in other services, a decrease of $1.3 million in prepaid voice services, a decrease of $0.5 million in wireless services, a decrease of $0.1 million in data and hosting services and a decrease of $0.1 million in VoIP services offset, in part, by an increase of $0.3 million in Internet services. Inclusive of the currency effect which accounted for a $0.3 million decrease, net revenue decreased $8.6 million to $51.2 million for the three months ended March 31, 2013 from $59.8 million for the three months ended March 31, 2012. Cost of revenue: Cost of revenue, exclusive of the currency effect, decreased $3.9 million to $29.6 million, or 48.4% of net revenue, for the three months ended March 31, 2013 from $33.5 million, or 49.3% of net revenue, for the three months ended March 31, 2012. Inclusive of the currency effect, which accounted for a $0.1 million decrease, cost of revenue decreased $4.0 million to $29.5 million for the three months ended March 31, 2013 from $33.5 million for the three months ended March 31, 2012. Inclusive of Exclusive of Currency Effect Currency Effect Quarter Ended Quarter-over-Quarter Quarter Ended March 31, 2013 March 31, 2012 March 31, 2013 Cost of % of Net Cost of % of Net Currency Cost of % of Net (in thousands) Revenue Revenue Revenue Revenue Variance Variance % Effect Revenue Revenue BLACKIRON Data $ 4,469 46.1 % $ 3,377 41.2 % $ 1,092 32.3 % $ (31 ) $ 4,438 46.1 % North America Telecom 25,156 48.8 % 30,128 50.4 % (4,972 ) -16.5 % (124 ) 25,032 48.8 % Total Cost of Revenue $ 29,625 48.4 % $ 33,505 49.3 % $ (3,880 ) -11.6 % $ (155 ) $ 29,470 48.4 % BLACKIRON Data: BLACKIRON Data cost of revenue, exclusive of the currency effect, increased $1.1 million to $4.5 million, or 46.1% of net revenue, for the three months ended March 31, 2013 from $3.4 million, or 41.2% of net revenue, for the three months ended March 31, 2012. The increase is primarily attributable to an increase in net revenue of $1.5 million. Inclusive of the currency effect, which accounted for an insignificant decrease, cost of revenue increased $1.0 million to $4.4 million for the three months ended March 31, 2013 from $3.4 million for the three months ended March 31, 2012. 44 -------------------------------------------------------------------------------- North America Telecom: North America Telecom cost of revenue, exclusive of the currency effect, decreased $5.0 million to $25.1 million, or 48.8% of net revenue, for the three months ended March 31, 2013 from $30.1 million, or 50.4% of net revenue, for the three months ended March 31, 2012. The decrease is primarily attributable to a decrease in net revenue of $8.3 million. Inclusive of the currency effect, which accounted for a $0.1 million decrease, cost of revenue decreased $5.1 million to $25.0 million for the three months ended March 31, 2013 from $30.1 million for the three months ended March 31, 2012. Selling, general and administrative expenses: Selling, general and administrative expenses ("SG&A"), exclusive of the currency effect, decreased $4.5 million to $22.7 million, or 37.0% of net revenue, for the three months ended March 31, 2013 from $27.2 million, or 39.9% of net revenue, for the three months ended March 31, 2012. Inclusive of the currency effect, which accounted for a $0.1 million decrease, SG&A decreased $4.6 million to $22.6 million for the three months ended March 31, 2013 from $27.2 million for the three months ended March 31, 2012. Inclusive of Exclusive of Currency Effect Currency Effect Quarter Ended Quarter-over-Quarter Quarter Ended March 31, 2013 March 31, 2012 March 31, 2013 % of Net % of Net Currency % of Net (in thousands) SG&A Revenue SG&A Revenue Variance Variance % Effect SG&A Revenue BLACKIRON Data $ 2,240 23.1 % $ 1,310 16.0 % $ 930 71.0 % $ (13 ) $ 2,227 23.1 % North America Telecom 15,970 31.0 % 19,056 31.9 % (3,086 ) -16.2 % (67 ) 15,903 31.0 % Corporate 4,445 0.0 % 6,790 0.0 % (2,345 ) -34.5 % - 4,445 0.0 % Total SG&A $ 22,655 37.0 % $ 27,156 39.9 % $ (4,501 ) -16.6 % $ (80 ) $ 22,575 37.1 % BLACKIRON Data: BLACKIRON Data SG&A, exclusive of the currency effect, increased $0.9 million to $2.2 million, or 23.1% of net revenue, for the three months ended March 31, 2013 from $1.3 million, or 16.0% of net revenue, for the three months ended March 31, 2012. The increase is primarily attributable to an increase of $0.7 million in salaries and benefits, an increase of $0.1 million in advertising expenses and an increase of $0.1 million in travel and entertainment expenses and professional fees. Inclusive of the currency effect, which accounted for an insignificant decrease, SG&A increased $0.9 million to $2.2 million for the three months ended March 31, 2013 from $1.3 million for the three months ended March 31, 2012. North America Telecom: North America Telecom SG&A, exclusive of the currency effect, decreased $3.1 million to $16.0 million, or 31.0% of net revenue, for the three months ended March 31, 2013 from $19.1 million, or 31.9% of net revenue, for the three months ended March 31, 2012. The decrease is attributable to a decrease of $1.5 million in salaries and benefits, a decrease of $0.7 million in sales and marketing expenses, a decrease of $0.5 million in general and administrative expenses, a decrease of $0.2 million in advertising expenses, a decrease of $0.1 million in professional fees and a decrease of $0.1 million in occupancy expenses. Inclusive of the currency effect, which accounted for a $0.1 million decrease, SG&A decreased $3.2 million to $15.9 million for the three months ended March 31, 2013 from $19.1 million for the three months ended March 31, 2012. Corporate: Corporate SG&A decreased $2.3 million to $4.4 million for the three months ended March 31, 2013 from $6.8 million for the three months ended March 31, 2012. The decrease is attributable to a decrease of $2.2 million in salaries and benefits and a decrease of $0.3 million in general and administrative expenses offset, in part, by an increase of $0.1 million in professional fees and an increase of $0.1 million in occupancy expenses. 45 -------------------------------------------------------------------------------- Depreciation and amortization expense: Depreciation and amortization expense decreased $1.0 million to $6.6 million for the three months ended March 31, 2013 from $7.6 million for the three months ended March 31, 2012. The decrease is attributable to a decrease in the amortization of our Canadian customer list intangible asset. This intangible asset is amortized over a useful life that corresponds to the diminishing projected cash flows in the fresh start valuation model so future amortization expense will continue to decline. Interest expense and accretion (amortization) on debt premium/discount, net: Interest expense and accretion (amortization) on debt premium/discount, net decreased $2.7 million to $4.2 million for the three months ended March 31, 2013 from $6.9 million for the three months ended March 31, 2012. The decrease was due to the repurchase of a portion of the outstanding 10% Notes in September 2012. See Note 4-"Long-Term Obligations" to the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Gain (loss) from contingent value rights valuation: The loss from the change in fair value of the contingent value rights decreased $7.3 million to a $0.1 million gain for the three months ended March 31, 2013 from a $7.2 million loss for the three months ended March 31, 2012. Estimates of fair value represent the Company's best estimates based on a pricing model and are correlated to and reflective of our common stock trends. Generally, as the fair value of our common stock increases/decreases, the fair value of the contingent value rights increases/decreases and a loss/gain from contingent rights valuation is recorded. Foreign currency transaction gain (loss): Foreign currency transaction gain decreased $2.0 million to an insignificant gain for the three months ended March 31, 2013 from a gain of $2.0 million for the three months ended March 31, 2012. The gains and losses are attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivables and payables denominated in a currency other than the subsidiaries' functional currency. We incurred a foreign currency transaction gain on the intercompany payable balances that our Canadian subsidiaries have with our US subsidiaries due to an increase in the exchange rate from January to March 2012. Income tax benefit (expense): Income tax benefit decreased $1.2 million to an expense of $0.1 million for the three months ended March 31, 2013 from a benefit of $1.1 million for the three months ended March 31, 2012. Included in the expense is a provision for foreign withholding tax, state taxes and an "ASC 740" provision, partially offset by prior year return to provision benefit adjustment. Liquidity and Capital Resources Important Long-Term Liquidity and Capital Structure Developments: Divestiture of BLACKIRON On April 17, 2013, pursuant to the BLACKIRON Purchase Agreement, we consummated the BLACKIRON Transaction in which we divested our BLACKIRON subsidiary, which operated our BLACKIRON Data business unit, for a purchase price of approximately CAD$200 million. The purchase price is subject to potential downward or upward post-closing adjustments based on net working capital and cash at closing. In addition, CAD$20 million of the purchase price was placed in escrow to be released 15 months after the closing date, subject to any deductions required to satisfy indemnification obligations of PTGi and PTCI under the BLACKIRON Purchase Agreement. The BLACKIRON Purchase Agreement also contains customary indemnification obligations, representations, warranties and covenants for a transaction of this nature. In addition, subject to certain exceptions, PTGi and its subsidiaries also agreed for a period of two years from the closing date to certain restrictions on competing with BLACKIRON as provided in the BLACKIRON Purchase Agreement. The BLACKIRON Transaction was approved by the Board of Directors of PTGi as well as the Special Committee of the Board of Directors of PTGi. 46 -------------------------------------------------------------------------------- Pending Divestiture of North America Telecom On May 10, 2013, PTGi announced that PTGi and each of PTHI, Primus Telecommunications International, Inc. ("PTII") and Lingo Holdings, Inc. ("Lingo Holdings", and together with PTHI and PTII, the "Sellers"), direct or indirect wholly owned subsidiaries of PTGi, entered into an equity purchase agreement dated as of May 10, 2013 (the "North America Telecom Purchase Agreement") with PTUS, Inc. ("US Acquireco") and PTCAN, Inc. ("CAN Acquireco" and together with US Acquireco, the "Purchasers"), affiliates of York Capital Management, an investment firm, to sell to the Purchasers all of the outstanding equity of each of Primus Telecommunications, Inc. ("PTI"), Lingo, Inc. ("Lingo"), iPrimus, USA, Inc. ("iPrimus"), 3620212 Canada Inc. ("Primus Canada"), Primus Telecommunications Canada Inc. ("PTCI"), Telesonic Communications Inc. ("Telesonic"), and Globility Communications Corporation ("Globility", and together with PTI, Lingo, iPrimus, Primus Canada, PTCI and Telesonic, the "Companies"), indirect or direct wholly owned subsidiaries of PTGi, for approximately $129 million (the "North America Telecom Transaction"). The purchase price is subject to potential downward or upward post-closing adjustments based on net working capital and cash at closing. The North America Telecom Purchase Agreement contains customary indemnification obligations, representations, warranties and covenants for a transaction of this nature. Certain indemnification obligations are subject to a cap of approximately $12.9 million. In addition, the North America Telecom Purchase Agreement provides that the Sellers must, for 14 months after the closing of the North America Telecom Transaction, maintain a minimum balance of cash and cash equivalents necessary to satisfy PTGi's indemnification obligations under the North America Telecom Purchase Agreement. Pursuant to the terms of the North America Telecom Purchase Agreement, $6.45 million of the purchase price will be placed in escrow to be released 14 months after the closing date, subject to any deductions required to satisfy indemnification obligations of PTGi under the North America Telecom Purchase Agreement. In addition, $4 million of the purchase price will be placed in escrow to cover any payments required in connection with the post-closing working capital and cash adjustments, which escrow amount will be released when such adjustments are conclusively agreed upon. Furthermore, $4.8 million of the purchase price will be placed in escrow to cover certain tax liabilities, which escrow amount will be released after a positive ruling with respect to the underlying matter is received or 30 days after expiration of the applicable statute of limitations relating to the underlying matter. The North America Telecom Purchase Agreement also contains certain termination rights for PTGi, the Sellers and the Purchasers, including the right of PTGi and the Sellers, in certain circumstances, to terminate the North America Telecom Purchase Agreement and accept a superior proposal. If the North America Telecom Purchase Agreement is terminated, in certain circumstances, the Sellers would be required to pay to the Purchasers reasonable costs and expenses incurred by the Purchasers of up to 1% of the purchase price or a termination fee equal to $3.87 million. In certain circumstances in which the North America Telecom Purchase Agreement is terminated or the Purchasers breach the North America Telecom Purchase Agreement, Purchasers would be required to pay to PTGi a reverse termination fee equal to $25 million as liquidated damages. The Companies conduct PTGi's North America retail telecommunications operations in the United States and Canada. The transactions contemplated by the North America Telecom Purchase Agreement were approved by the Board of Directors of PTGi as well as the special committee of the Board of Directors of PTGi. The North America Telecom Transaction will require PTGi stockholder approval and regulatory approvals, and is subject to customary closing conditions. The North America Telecom Transaction is currently expected to close by the third quarter of the year ending December 31, 2013, with the exception of the sale of PTI. Subject to regulatory approvals, the sale of PTI is expected to close subsequent to the third quarter of the year ending December 31, 2013. Approximately $126 million, subject to any adjustments pursuant to the North America Telecom Purchase Agreement, is required to be paid on the initial closing, with the remainder to be paid upon closing of the sale of PTI. 47 -------------------------------------------------------------------------------- Continued Pursuit of Divestiture of ICS Business Unit In connection with the Special Committee's evaluation of strategic alternatives to maximize shareholder value, the Company's Board of Directors committed to dispose of the Company's ICS business unit on June 28, 2012 and continues to actively solicit a sale or other disposition of such business unit. As a result of holding the ICS business unit out for sale, such business unit has been classified as a discontinued operation and its held for sale assets and liabilities have been removed from the specific line items on the condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012. See Note 11-"Discontinued Operations" to the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Changes in Cash Flows Our principal liquidity requirements arise from cash used in operating activities, purchases of network equipment, including switches, related transmission equipment and capacity, development of back-office systems, expansion of data center facilities, interest and principal payments on outstanding debt and other obligations and income taxes. We have financed our growth and operations to date through public offerings and private placements of debt and equity securities, vendor financing, capital lease financing and other financing arrangements. Net cash used in operating activities was $1.4 million for the three months ended March 31, 2013 as compared to net cash provided by operating activities of $18.0 million for the three months ended March 31, 2012. For the three months ended March 31, 2013, net income, net of non-cash operating activity, provided $4.6 million of cash. Other major drivers included an increase in accrued interest of $3.2 million and a decrease in prepaid expenses and other current assets of $1.0 million, partially offset by a decrease in accrued expenses, deferred revenue, other current liabilities and other liabilities, net of $6.4 million, an increase in accounts receivable of $2.2 million and a decrease in accrued interconnection costs of $1.7 million. Net cash used in investing activities was $6.9 million for the three months ended March 31, 2013 as compared to $9.5 million for the three months ended March 31, 2012. Net cash used in investing activities during the three months ended March 31, 2013 included $6.5 million of capital expenditures and $0.4 million used in the acquisition of businesses. Net cash used in financing activities was $0.9 million for the three months ended March 31, 2013 as compared to $3.9 million for the three months ended March 31, 2012. Net cash used in financing activities during the three months ended March 31, 2013 included $0.4 million used to satisfy the tax obligations for shares issued under share-based compensation arrangements, $0.4 million used to pay dividend equivalents to our shareholders and $0.1 million used to reduce the principal amounts outstanding on capital leases. Short- and Long-Term Liquidity Considerations and Risks; Contractual Obligations As of March 31, 2013, we had $13.8 million of cash and cash equivalents. We believe that our existing cash and cash equivalents will be sufficient to fund our debt service requirements, other fixed obligations (such as capital leases, vendor financing and other long-term obligations) and other cash needs for our operations for at least the next twelve months. As of March 31, 2013, we had $10.2 million in future minimum purchase obligations, $50.8 million in future operating lease payments and $127.8 million of indebtedness. 48 -------------------------------------------------------------------------------- The obligations set forth in the table below reflect the contractual payments of principal and interest that existed as of March 31, 2013: Payments Due By Period Contractual Obligations Total Less than 1 year 1-3 years 3-5 years More than 5 years 13% Senior Secured Notes due 2016 $ 3,652 $ 312 $ 624 $ 2,716 $ - 10% Senior Secured Notes due 2017 18,403 1,269 2,538 14,596 - 10% Senior Secured Exchange Notes due 2017 162,377 10,383 22,518 129,476 - Capital leases and other 87 51 36 - - Operating leases 50,837 8,703 16,134 11,930 14,070 Purchase obligations 10,212 3,786 4,748 746 932 Total minimum principal & interest payments 245,568 24,504 46,598 159,464 15,002 Less: Amount representing interest (56,757 ) (11,968 ) (25,683 ) (19,106 ) - Total contractual obligations $ 188,811 $ 12,536 $ 20,915 $ 140,358 $ 15,002 We have contractual obligations to utilize network facilities from certain carriers with terms greater than one year. We generally do not purchase or commit to purchase quantities in excess of normal usage or amounts that cannot be used within the contract term. New Accounting Pronouncements For a discussion of our "New Accounting Pronouncements," refer to Note 2-"Summary of Significant Accounting Policies" to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Related Party Transactions The Company had no transactions with related parties in the three months ended March 31, 2013 and 2012. Special Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains or incorporates a number of "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based on current expectations, and are not strictly historical statements. In some cases, you can identify forward-looking statements by terminology such as "if," "may," "should," "believe," "anticipate," "future," "forward," "potential," "estimate," "opportunity," "goal," "objective," "growth," "outcome," "could," "expect," "intend," "plan," "strategy," "provide," "commitment," "result," "seek," "pursue," "ongoing," "include" or in the negative of such terms or comparable terminology. These forward-looking statements inherently involve certain risks and uncertainties and are not guarantees of performance, results, or the creation of shareholder value, although they are based on our current plans or assessments which we believe to be reasonable as of the date hereof. Factors or risks that could cause our actual results to differ materially from the results we anticipate include, but are not limited to: • the proposed divestiture of PTGi's North America Telecom operations, including the risk that we may not obtain stockholder and regulatory approval of the transactions contemplated by the definitive agreement on the proposed terms and schedule; the risk that the transaction will impair our ability to maintain third party relationships following the announcement of the transaction; the risk that the parties may not be able to satisfy the conditions to closing of the transactions contemplated by the definitive agreement; and the risk that the transactions contemplated by the definitive agreement may not be completed in the time frame expected by the parties or at all; 49 -------------------------------------------------------------------------------- • continuing uncertain global economic conditions; • significant changes in the competitive environment, including as a result of industry consolidation, and the effect of competition in our markets, including our pricing policies; • uncertainties from our announcement of our exploration and evaluation of strategic alternatives that may enhance shareholder value or our ability to complete any transactions arising out of that evaluation, including the pursuit of a divestiture of our ICS business unit; • our possible inability to generate sufficient liquidity, margins, earnings per share, cash flow and working capital; • our ability to attract and retain customers; • our expectations regarding increased competition, pricing pressures and declining usage patterns in our traditional products; • the effectiveness and profitability of our growth products and bundled service offerings, the pace and cost of customer migration onto our networks and the successful network platform migration to reduce costs and increase efficiencies; • volatility in the volume and mix of trading activity on the Arbinet Exchange; • strengthening of the U.S. dollar against foreign currencies, which may reduce the amount of U.S. dollars generated from foreign operating subsidiaries and adversely affect our ability to service our significant debt obligations and pay corporate expenses; • our compliance with complex laws and regulations in the U.S. and internationally; • further changes in the telecommunications or Internet industry, including rapid technological, regulatory and pricing changes in our principal markets; • our liquidity and possible inability to service our substantial indebtedness; • an occurrence of a default or event of default under our indentures; • our expectations regarding the timing, extent and effectiveness of our cost reduction initiatives and management's ability to moderate or control discretionary spending; • management's plans, goals, forecasts, expectations, guidance, objectives, strategies and timing for future operations, acquisitions, synergies, asset dispositions, fixed asset and goodwill impairment charges, tax and withholding expense, selling, general and administrative expenses, product plans, performance and results; • management's assessment of market factors and competitive developments, including pricing actions and regulatory rulings; • our possible inability to raise additional capital when needed, on attractive terms, or at all; and • our possible inability to hire and retain qualified executive management, sales, technical and other personnel. Other unknown or unpredictable factors could also affect our business, financial condition and results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that any of the estimated or projected results will be realized. You should not place undue reliance on these forward-looking statements, which apply only as of the date hereof. Subsequent events and developments may cause our views to change. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. 50-------------------------------------------------------------------------------- [ Back To TMCnet.com's Homepage ]